Busch: Disconcerting Deflation Developments

Words My Mom Taught Me To Fear: We're From the Government and We're Here To Help

There are a number of disconcerting deflation developments:

First, Sweden announces that they will not bail out Saab Automobile after GM cut ties to the car company. Sweden has ruled out taking over Saab, saying taxpayers money shouldn't be pumped into a company that's been unprofitable for 19 of the last 20 years. Saab has filed for protection from creditors in a Swedish court and the reorganization is expected to take three months.

Next according to MNI, China's Ministry of Commerce (MofComm) will enact six major measures to help shore up rapidly declining machinery exports, the official Xinhua News Agency reports, citing a vice minister. "China machinery exports stood at $49.14 billion in January, down 20.9% year-over-year, down for the third consecutive month. Machinery exports accounted for 54.3% of total exports in January. Weakness of this extent has "not been seen in more than twenty years", Jiang Yaoping, vice director of MofComm was quoted as saying." Increasing production when demand is down drives prices lower.

Canada announced their consumer prices fell 0.3% in January, further trimming the annual inflation rate to 1.1% from 1.2% the prior month, and down from a peak of 3.5% last August according to our Doug Porter. "The big driver for core in the month was a hefty 5.3% m/m drop in auto prices, reversing much of the loonie-related spike two months ago, and taking car prices down 8.2% y/y. Electricity prices also fell 1% m/m....Bottom Line: ...With the economic downturn gathering force and commodity prices still reeling, inflation is poised to move decisively lower in the months ahead. A temporary dip into negative inflation readings looms in the spring."

Also, Kalifornia has a budget! All it took was withholding certain personal freedoms to get the politicians to accept the terms that everyone hates: tax hikes and reduced spending. For the state that has an economy larger than all but 10 countries, this was clearly a difficult decision, but a mandatory one. California was facing a budget deficit of $41 billion. The pact contains $14.8 billion in spending cuts, including to public transit, health care, schools and the courts; $12.5 billion in tax increases; $5.4 billion in new borrowing; and the creation of a $1 billion reserve fund according to the NYT. This is seen as a paradigm for at least 40 states that are currently in the red.

Today, we have lots of rumors circulating about the "nationalization" of Citigroup and BofA. This type of thinking is being fueled by the lack of disclosure by the FDIC on their plan to stress test financial firms and effectively give a clean bill of health to the remaining firms. This further drives down the value of financial stocks as fears over what a "nationalization" or liquidation would mean.

All of these contribute and define a deflation spiral. Do you notice a pattern? They appear to be all government inflicted. The question now is will the cure be worse than the disease? The annual growth rate in the St. Louis Federal Reserve's Adjusted Monetary Based was up 81.9% for the first two weeks of February vs stratospheric 103.3% in the previous period and 107.2% in the period before that! The lesson here is that the markets will remain extremely volatile and unpredictable due to the large reach of not the invisible hand, but the government hand into the economy.

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Andrew Busch

Andrew B. Busch is Global FX Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him here. </</p>